Funding cash flow shortfalls
This Article was posted on 04.02.11 in Managing
A temporary cash flow shortfall can place considerable stress on a business and is likely to affect your ability to operate effectively and efficiently. While your goal should always be to avoid shortfalls, cash flow issues can arise despite your best efforts, and for reasons outside your control. An unexpected drop in sales can cause a shortfall, an important customer not paying on time can wreck havoc with your cash flow, or it could simply be taking longer than expected to get your business start-up to finally turn a profit.
Use realistic cash flow forecasts
It's best to work out a best case and worst case cash flow forecast, so that you have a good idea of what your future financial needs will be. The first questions you’ll be asked when you approach someone to help with additional finance, is: “How much do you need?”
If you have detailed information and forward projections at hand it will be easier to talk to your bank manager about loaning extra money, or to attract other forms of finance. This will also give you a good indication of how long you’ll need the money for as well.
Talk to your advisers
Before you rush out and take on more debt to finance your business operations, it is a good idea to make sure that it’s in your best interests to do so. If your business is no longer viable, there's little point in taking out more debt to postpone the inevitable – it will only end up costing you more.
If you suspect your cash flow shortfall is not temporary you should discuss your financial situation with your advisers before you take on additional debt. It might be in your best interests to cut your losses sooner rather than later.
Even if the shortfall is likely to be temporary, it’s still a good idea to chat to your accountant or advisers to make sure that you make the right decision for your business. They deal with business finance all the time and will be able to suggest where to go for help, and advise you on the latest rates and what you can expect to pay.
Sourcing finance
There are a number of options to consider when looking to finance cash flow shortfalls, ranging from self financing or bank loans through to finding a business partner or angel investor. The relative attractiveness of each option will depend on the likely size of your cash flow shortfall, and how long you’re likely to need the cash for.
Self finance
Self financing is one option to consider. If you have savings this might be a once-off cash injection. Alternatively you can use your personal credit card to pay for some business purchases to ease cash flow, or take out a personal loan to tide your business through a temporary rough patch. You might also consider taking a loan out against your home.
Self finance is likely to feel like an easy option for you if you’re facing a cash flow shortfall because you don’t have to tell anyone you’re battling, or ask either friends or strangers for help. It is important not to let your personal pride get in the way of what is best for your business. Bear in mind that putting more of your personal resources into the business might not be in your long-term best interests, and battling through a cash flow shortfall on your own is harder than doing it with the support of family and friends.
Family and friends
You can ask family, friends or business colleagues to help out with a temporary or longer-term loan. The attractiveness of this option is:
- You don’t have to go to a bank or stranger to discuss the worth of your business
- There is a good chance that family and friends will offer you a loan at with no interest, or a lower interest rate than you’d get from banks.
You’ll probably be tempted to accept the loan on a handshake, but it is a good idea to put the agreement in writing and get everyone to sign it, so that both sides are clear on what has been agreed. Be aware that this sort of agreement could strain some personal or working relationships.
Bank loans
Asking for more money from your bank is another option to consider. If you have a good banking track record it could be little more than a formality to get a higher overdraft facility, or access to a business loan, to tide you over. However, if you’re going to need quite a lot more money you’ll probably have to present a more detailed business plan and financial forecasts. The bank will use this to assess the risk of lending the money to you and make a decision.
Invoice discounting
Invoice discounting or factoring is an option to consider to ease cash flow issues if most of your business is based on credit sales. The factoring house would agree to pay you a percentage (usually around 80%) of your invoiced sales each week. They would pay the balance, less any agreed administration and other fees when the money was paid to them by your creditor. The factoring house will want to check out your business and the people you do business with to assess the risk before working with you. It is in your interests to find out all the costs and compare invoice discounting with more traditional avenues of finance. Also find out how long you’ll be tied into discounting your invoices and what your options are if you want to withdraw from the agreement once your cash flow is more settled.
Partners and investors
If you’re looking for a sizeable amount of money or have a situation that requires a longer term investment you could also consider taking on a business partner or finding someone, like an angel investor, bizAngel or venture capitalist, to invest in your business. You’ll need to be prepared to share the ownership of your business in order to consider this option.
Compare costs
Most small business owners tend to grab the first offer of financial assistance that is extended and turn their attention back to the nuts and bolts of running a business, but this is not the best way to go about funding your cash flow shortfall. The first step is to find out all the financing options available to you, then detail the costs associated with each option. Try to list opportunity and relationships costs as well the financial costs. Only then will you be in a position to make the best decision for you and your business.
An interest-free five-year loan from your spouse, for example, might be the cheapest way to access cash – but only you will know how whether this will interfere with your personal or business relationship. On the other hand factoring might turn out to be the least-cost option available to you. But factoring can sometimes be seen in a negative light and you’d need to consider whether this would affect the perceptions of your suppliers or customers.
Unless the option you choose locks you into a long-term agreement, you might also want to consider putting a note in your diary to review your financing options in a few months, or at least within 12 months time.
Next Steps
- Prepare a best and worst case cash flow forecast to establish how much money you will need, and how long you’re likely to need it for.
- Discuss your cash flow situation and financing options with your business advisers.
- Identify all the sources of finance open to you. Talk to the people concerned and find out all the terms and costs, and the best terms they’re prepared to give you.
- Compare the relative costs, (monetary and non-monetary) to decide on the best option for your business, and build in a review period where this is appropriate.
Content provided by The Small Business Company
